Flow-Based Asset Pricing: Maximum Price Impact Ratio


We analyze the flow-driven fluctuations of the cross section of asset prices. We take the stance that price impacts of uninformative flows arise as marginal investors’ risk compensation. We show that shorting the portfolio that incurs the maximum price impact for a given level of fundamental risk is the most efficient trading-against-flow strategy. To form this strategy, we build a new model of common factors of flows and common factors of fundamental returns and estimate the model using U.S. equity mutual fund flows into Fama-French three factors. Our strategy increases the out-of-sample annualized Sharpe ratio of 154 firm characteristics-based anomaly portfolios by an average of 0.3. Our evidence shows that risk-driven price impacts depend only on factor flows but not on idiosyncratic flows.


Notre Dame, Johns Hopkins Carey